Entitled
"Equity and Development," the World Development Report
(WDR)2006 of the World Bank is a great leap backward in development
thinking. Ignoring the lessons of 50 years of experience, it advocates
bringing equity to the centre stage of development-policy making.

The report is not oblivious to the fact that virtually all agree that
the central goal of development policy should be to tackle poverty, not
inequity.

That would be impossible since the slogan “Our dream is a world free
of poverty” is prominently displayed on virtually all walls of the
opulent World Bank building. But the report contends that the pursuit of
equity speeds up the elimination of poverty. “Equity enhances the
power of growth to reduce poverty,” says the press release launching
the report.

It is an elementary point that greater equity does not guarantee less
poverty even holding the total national income constant. Take one
billion dollars away from Narayana Murthy and distribute it equally
among 1,000 existing millionaires. You will get greater equity but not
less poverty.

Indeed, given the prospect that as a billionaire Murthy is likely
to engage in greater philanthropy than the 1,000 millionaires, the
redistribution may reduce the potential for future poverty reduction.

But let me concede that for a given national income, a more equitable
distribution would yield greater poverty reduction. The critical
question then is whether once you adopt equity as an objective or an
active instrument of poverty reduction, the policies that sustain high
rates of growth of national income would themselves be sustained. In
asking this question, we must distinguish between policies targeting
poverty directly that were the subject matter of the WDR 2000/2001 and
those targeting income distribution on which WDR 2006 focuses.

Anyone well versed in the history of policy making in India would get
chills at the thought of targeting income distribution. Virtually all
anti-growth and anti-poor policies India has been dismantling for the
last two decades have their origins in the pursuit of equity.

Thus, the desire to establish a socialistic pattern of society was at
the heart of the dominant role the Indian policy makers gave to the
public sector in the industry. The same desire also contributed to the
control of private sector through industrial licensing.

And when the liberal foreign investment policy and relatively
relaxed investment and import licensing regime in the 1950s led to rapid
growth of private industry and the emergence of several large industrial
houses, it was once again the concern for equity, viewed as an
instrument of poverty eradication (remember the slogan garibi hatao?),
that led Indira Gandhi to erect the massive regulatory structure that
even 20 years of reforms have not been able to entirely demolish.

To cap the concentration of economic power in the industry, Gandhi
confined all future investments of undertakings with more than Rs 20
crore ($27 milion) invested in land, building and machinery to a
narrow list of 19 “core” industries. At the other extreme, she
reserved many labour-intensive products for the exclusive production by
small-scale units — entities with investment in machinery and plant
not exceeding Rs 750,000 ($100,000).

Considerations that large banks did not adequately lend to the smaller
enterprises or open rural branches led Gandhi to nationalise them. She
also restricted foreign equity in an enterprise to 40%. Undertakings
with 100 or more workers were denied the right to fire the latter. The
acquisition of vacant land in the great cities by households and firms
was limited to just 500 square metres. Marginal income-tax rates at even
modest incomes were set at 95%.

The WDR makes no serious attempt to underline the hazards of the
preoccupation with equity to which the Indian experience points.
Instead, it notes in passing that the ‘history of the twentieth
century is littered with examples of ill-designed policies pursued in
the name of equity that seriously harmed — rather than spurred —
growth,’ and proceeds to sing the song of complementarity among
equity, growth and poverty reduction.

It makes no attempt to confront the question whether politics would
allow the government to selectively choose those equity-oriented
policies that promote growth and reduce poverty or force its hand in the
opposite direction. There may be a good reason why history is what it
is.

The WDR also comes short on analytic
sharpness. In support of the view that equity and efficiency go
together, in chapter 5, it argues that the relaxation of credit
constraints faced by small entrepreneurs may result in the realisation
of huge returns. As an example, it cites a study by distinguished
economists Abhijit Banerjee and Esther Duflo. In 1998, India changed the
investment limit defining small-scale units from Rs 65 lakh to Rs 3
crore. This change qualified the firms with investments between Rs 65
lakh and Rs 3 crore to access the priority-sector lending available to
small-scale units.

Banerjee and Duflo estimate that the resulting increment in the
availability of working capital allowed these firms to reap a rate of
return of 94%! While interesting in itself, the finding raises at least
two questions. First, at rates of returns of 94%, why do the banks not
lend to these firms even absent priority sector lending requirement?

And why do large firms not invest their retained earnings and households
their savings in them either? Are all agents in the economy credit
constrained? If yes, this points to a fundamental problem with financial
intermediation. If not, how can we be sure that returns in other
activities are not even higher?

Second, if the extension of priority sector lending leads these
enterprises to receive extra credit at the cost of even smaller
enterprises, the impact of the change is to increase, not reduce equity.
Recall the objective behind the original restriction on priority sector
lending to units below Rs 65 lakh in investment was precisely to promote
equity. The WDR does not even raise these questions, let alone grapple
with them.